Professor Karl Whelan:

I might follow up with a similarly two-handed approach, but try to give a bit more depth than I gave in my opening statement.

In terms of the position that it will go back to inflation being low and below 2%, it is interesting that the ECB's position, as expressed by Professor Philip Lane in the past couple of days, both in a speech and in an interview that he gave, was much stronger that, in Europe at least, the ECB is very confident that inflation is returning to 2%. That statement is much stronger than those being made by central bankers in the UK or at the Federal Reserve. Professor Lane's argument is basically that there is a set of circumstances that have been in place in Europe dating back to 2008-2009 which have together meant systematically low inflation and the ECB has put in place historically unprecedented levels of stimulus from the central bank and still not seen inflation rise that much. They look at the pandemic and they say that after the pandemic, all the forces that were in place that were leading to there being not much pricing power for firms, and perhaps demographic factors that mean that lots of people in Europe are saving rather than spending, are still all in place. The pandemic did not make any of those go away. I think that is their ultimate argument for why it is that these forces will recede and we will end up sometime next year looking around and the economy will look much like it did before the pandemic, and in that era the economy was structurally almost incapable of delivering high inflation. I think that is their argument.

I will give one argument as to why they are somewhat on shaky ground and give the inside baseball on this topic in the profession. Neither the central banking community nor the academic economics community is currently feeling that it has a very good theory of the determinants of inflation. The Federal Reserve for years relied on what we call the "Phillips curve", which is, basically, if the unemployment rate gets low and the economy gets hot, you will see inflation. The Federal Reserve, Fed, more or less walked away from the Phillips curve as a framework in the period prior to the pandemic. Mr. Jerome Powell, the Fed chair, oversaw a review of the monetary policy and their previous cycle where they had raised interest rates was not because they had seen high inflation but only because unemployment was low. Within that framework, you have to come out and say "We actively want to raise unemployment", which, if you think about, means there are people in jobs now when we actively want them to not be in jobs because we think their being in jobs is a threat to inflation. When they went through that, the inflation never appeared. Therefore, even prior to the pandemic, the Federal Reserve had been cutting inflation. A prominent member of the Federal Reserve board, on quitting his seven-year position a couple of years go, Professor Daniel Tarullo, stated it was his assessment that the Federal Reserve did not have a working model of inflation that was useful. There was a recent paper by a very senior Federal Reserve economist, who is an old friend of mine and somebody I wrote a number of academic papers with, Dr. Jerome Rudd, who has been a bit of a cause célèbrein the central banking and macroeconomic world where he said that lots of these theories that we have, that everything is driven by inflation expectations and central banks are able to anchor inflation expectations by going out and giving speeches, are all nonsense and nobody listens to central banks.

Dr. Rudd's concern, I guess, is that when people - to follow up on the final point Dr. Kavanagh made - get concerned about inflation it starts to influence their decision-making, and then it really matters. It does not matter until they wake up and it is 5% and then it does matter. The concern is the ECB's confidence and the Government's confidence that when the tides roll out we are just back in the same economy that we were and there just may be a day we wake up and realise that is not the case.